SEC puts new restrictions on short-selling

WASHINGTON (AP) — Federal regulators yesterday imposed new curbs on the practice of short-selling, hoping to prevent spiraling sales sprees in a stock that can stoke market turmoil.

The Securities and Exchange Commission, divided along party lines, voted 3-2 at a public meeting to adopt a new rule. Investors and lawmakers have clamored for the agency to put such brakes on trading moves they say worsened the market’s downturn in the fall of 2008.

The rule puts in a so-called circuit breaker for stock prices, restricting short-selling of a stock that has dropped 10 percent or more for the rest of a trading session and the next one. The new curbs take effect in about 60 days but stock exchanges have six months after that to implement them.

Short-sellers bet against a stock, in a practice that is legal and widely used on Wall Street. They borrow a company’s shares, sell them and then buy them when the stock falls and return them to the lender — pocketing the difference in price.

The SEC move fogollowed months of wrestling with the controversial issue. The SEC asked for public comment last April on several alternative approaches to restraining short-selling, and a bipartisan group of senators have pushed the agency to act or face legislation. The agency got more than 4,300 comments on the issue.

Sens. Ted Kaufman, D-Del., and Johnny Isakson, R-Ga., who head the group, called yesterday’s action by the SEC “a step forward” but said its effect will be limited, “helping only in the worst-case scenarios that could occur during a terrorist attack or financial crisis.”

What is needed, they said, is restoration of the Depression-era uptick rule, a permanent constraint allowing short-sellers to come in only at a price above the highest current bid for a stock. The SEC abolished the uptick rule in July 2007, when the stock market was near its peak.

The SEC staff estimates that only 1.3 percent of all stocks hit the 10 percent decline threshold during normal trading days without wild market swings.

Investor confidence was shaken as the market plunged amid the financial crisis in late 2008, and proponents of restoring restraints said they were needed to prevent abusive trading. They maintained that the absence of restraints fanned market volatility, prompting hedge funds and other aggressive investors to target weak companies with an avalanche of short-selling.

But opponents said new restrictions could eliminate the benefits of short-selling — bringing capital into the markets and accurate stock prices to the surface — and actually hurt investor confidence.

Under the new rule, once a “circuit breaker” has been triggered, short-selling in the affected stock will be permitted only if the price is above the current highest bid for the stock. That restriction would apply for the rest of the trading session and the next day’s session.

The SEC said the rule strikes a balance between two objectives: preventing short sellers from driving the price of a gutted stock even lower and preserving the benefits to investors from legitimate short-selling, such as pumping cash into the market. The balance comes, the agency said, because the “circuit breaker” restrictions are temporary and are applied to a specific trading session, in contrast to permanent alternatives.

“The reason this rule makes sense is because it recognizes that short-selling can potentially have both a beneficial and a harmful impact on the market — depending on the circumstances,” SEC Chairman Mary Schapiro said.